When Is A Pension Buyback Worth It?

Many workers have missed years of service in their employment history. Years away from work to raise children, recover from an illness or injury, go back to school, or other absence can reduce future pension payments. If you are enrolled in a defined benefit pension plan you may be allowed to buyback those periods during which you did not participate in the plan.

With defined benefit pension plans, your pension amount is tied to your earnings, age, and length of service. This number is called the pension factor.

A pension buyback can:

Increase your pension amount and survivor benefit, or

Allow you to retire sooner with no pension reduction.

Allowable periods and the amount of the buyback purchase vary according to the plan. Also, you have to still be employed with the company. You can’t have left your job, or be already retired.

Crunch the numbers

When you are faced with this decision it’s important that you do the math. The cost is the “actuarial value” (what the future value is worth today), and it depends on such things as your age, your salary, how many years you want to buyback, and when the past service occurred.

To know if the cost is worth the increased pension amount, compare the difference between what your pension will be with, and without, the buyback.

You can get a rough estimate of your benefits by using an online pension buyback calculator such as this one for HOOPP. For greater accuracy on your particular situation, check with your pension benefits administrator.

Consider these issues

There are a number of other issues that can affect your decision to buyback pensionable service:

Length of employment. The longer you work for the same employer, the more likely a buy-back will benefit you.

Your age. The younger you are, the less costly it will be. Buying back service in your mid-30’s may just set you back a few thousand dollars, but after age 50, the cost could be ten times more.

Employer contributions. In most cases your employer will also be making some contribution, so you will actually be only paying a portion of the true cost.

Can you afford the cost? The earlier you buyback past service, the less costly it will be. You can finance your buyback service with non-registered funds, or you can transfer directly from your RRSP. Sometimes your employer will allow you to buyback service over a period of time rather than force you to come up with one lump sum.

Life expectancy. Pension income will pay for as long as you live. If you think longevity is on your side, and you have no current health issues, an increased pension may make more sense. The survivor benefit may be worth it if your spouse is much younger than you.

Pension Buyback vs RRSP

For those enrolled in a defined benefit pension plan, it can be a cornerstone of your retirement income. Do you want the peace of mind of having a pension for life? A pension will give you steady income that is often partially or fully indexed to inflation. But it is more restrictive.

Consider the opportunity cost of removing capital from your RRSP for the years until age 60 or 65. Consider your expected rate of return for those years. An RRSP allows some flexibility to spend lump sums if you want to do that, or if your priorities change down the road.

The younger you are, the more you can save in your RRSP. But, if you have a smaller balance it may not be enough to maintain a decent standard of living or last the rest of your life.

Do you want to pass along an estate to your children or other beneficiary?

Final thoughts

While $100 – $200 extra per month may not seem like a big improvement, consider the long-term return of an increased pension amount.

A pension will provide a secure income for the rest of your life, and the life of your spouse. But, you will pay a price for that certainty.

11 Comments

Bryan
on May 6, 2017 at 8:54 am

I know this isn’t for the faint of heart, but I’m curious what your thoughts are on cashing out your DBPP, investing that lump sum, and living (almost) income tax free going forward by living off the dividends. Maybe it’s a future post, but would love to hear your two cents on this option.

@Bryan: I’ll give you my short answer – It depends.
There’s a lot of factors to consider here including length of employment, amount of lump sum, how committed you are to developing a good investment strategy that will work for you for your remaining years. My opinion is that good dividend payers are on the expensive side right now. Also, there’s a lot to be said about getting a guaranteed income for life especially since, as you get older, you likely want to go with more conservative investments and not worry about market fluctuations. Pension income (especially an index adjusted government pension) is as conservative as it gets.
I’ll think about expanding on this in a future post. Thanks for the suggestion.

You’re very right. There are so many factors. I’m thankful to have a full pension and this is still 25 years away for me but I have always been curious about this option. Who knows what taxes will be like in that time; the rumours were already floating around in this budget about increased tax on capital gains and such. Thanks for your insight!

Hope you are not fully depending on your full pension in 25 years as who knows. I was let go after 17 years and had to claw to retirement. I was lucky to know how to invest and have more money than I will ever need. I also took my pension as LIRA as “I” wanted to decide when to take it and how much. I would have to go thru hoops to get it if I have kept $$$ in the company pension plan.

Another reason to buy back pension time ASAP is that buyback is generally charged at your *current* hourly wage. For example, at my previous workplace you have 5 years within which to buy pensionable time lost to maternity leave – but in almost every case, your hourly wage is certainly lower now than it will be in 3-5 years’ time. (Sadly I’ve only heard this pointed out at our retirement seminars!)

I have been out of the work place and contributing to a law enforcement retirement for almost 20 years. I just went back to work in local government and have the opportunity to buy back my service time. it is going to be somewhere around 25K lump sum to buy back my time. I am 49 and trying to see if it is worth it. Any thoughts or do you need more info? I am healthy and have no medical conditions to make me not be able to work until 65. Thanks in advance

Hi Kerri. This may sound vague, but I suggest you look at the numbers before deciding what will be best for you. Most pension plans provide a calculator to help you evaluate.
Also consider: How many years of the increased pension amount will it take to get back your original purchase amount? How do you feel about investing that money yourself instead? Would you prefer the flexibility and easier access to the funds? Depending on your return (and be realistic) you could withdraw that same amount each year in retirement and still have a balance left after that same number of years.
Will your employer also make some sort of matching contribution?
Buying back your pension may allow you to retire sooner with no reduction in benefits.
Consider your expected longevity. Pension payments will be for life and may have survivor benefits. Your investment probably will run out at some point.
Finally, additional pension income will be taxed. Your $25K in a non-registered account will not be – only the return.
Good luck with your decision.

Quick question, I have bought back military years of service many years ago. I am now crunching the numbers and not sure if it was worth what I ended up paying. Before I calculate to the penny, can you tell if a buy back can be cancelled and money refunded to me?

Hi Eric. All pension regulations are different. Your best bet is to ask your pension administrator if your money can be refunded. They can also help you figure out the difference in your future pension payments. Good luck.

i paid into OMERS from 1990-1999. i moved to a new job which was not OMERS friendly so i had to put my OMERS into a lira. The Municipality i am with now finally joined in 2006 and I’ve been paying into one now. I looked into buying back service and retire but it was calculated at 198,000.00. Not doable. My LIRA value is around 85 thousand now.
I asked my financial adviser if i could use my LIRA to buy back as much service as it could to calculate how many more years i would have to work. He said no , and offered me nothing !
I am 57 years old, been diagnosed with prostate cancer , have received radiation and surgery and I have arthritis that is not fun to deal with every day.
My LIRA is from OMERS funds so can i use it to buy back OMERS to top me up an help me retire?

When “Buying back” years in a pension plan, Is the amount pay into the plan to reclaim a tax writeoff ? ie .. I pay $10,000 to buy back a few years .. is the $10,000 considered a writeoff due to payment into a retirement account ?